NOTE TO EDITORS: The Following is An Investment Opinion Issued by Spruce Point Capital Management
Reveals A Pattern Of Material Mischaracterizations Of The Company’s Organic Growth, Market Share, And Product Development Activities That Conflict With Decreasing Levels of Business Investment And Other Disclosures
Questions The Prospects Of A Highly Anticipated New Product Based On Our Survey Of Veterinarian Demand, Troubling Management Commentary, And A Competitor Product That Has Already Beaten Heska To Market By Over A Year
Identifies A Troubling Pattern Of Low-Quality Acquisitions And Provides Evidence That The Future Prospects Of Acquired Businesses Are Highly Questionable
Highlights Numerous Financial Reporting Issues Related To Heska’s Subscription Consumables Business And Acquisitions, As Well As The Failure To Adequately Disclose A Material Customer Product Return That Resulted In A Massive Mercury Disposal
Uncovers Numerous Governance Shortcomings, Including Unacceptable Conflicts Of Interest, Lack Of Disclosures, Unsavory Business Practices, And Questionable Executive Promotions Related To Heska CEO Wilson, CFO Grassman, And Several Operating Executives
Questions How Investors Can Ascribe A Poorly Positioned Distributor That Only Recently Acquired 40% Of Its Revenues For 1.4x Revenue An Industry Premium 9x Revenue Multiple
NEW YORK, October 25, 2021--(BUSINESS WIRE)--Spruce Point Capital Management, LLC ("Spruce Point" or "we" or "us"), a New York-based investment management firm that focuses on forensic research and short-selling, today issued a detailed report entitled "Scoop This Poop From Your Portfolio" that outlines why we believe shares of Heska Corporation (Nasdaq: HSKA) ("Heska" or the "Company"), face up to 60% downside risk to approximately $90.00 per share. Download the report by visiting www.SprucePointCap.com and follow us on Twitter @SprucePointCap for additional information and exclusive updates.
Spruce Point Report Overview
Heska is a distributor of diagnostic equipment and related consumables to veterinarians and a supplier of various animal health test kits, preventatives, and pharmaceuticals, largely manufactured on a contract basis for others. Following a period of negative organic growth and significant margin contraction from 2017 through 2019, Heska embarked on an acquisition spree and campaign to re-position the Company in the eyes of investors. Despite benefitting handsomely from the market’s embrace of the animal health investment theme, resulting in a more than doubling of its revenue multiple and a 140% rise in its stock price since the end of 2019, we find that Heska’s business, capabilities, and competitive position have barely changed.
We urge investors to review key findings in Spruce Point’s report ahead of the Company's third quarter 2021 earnings on November 4th, and hold management accountable for answers to the following issues:
Evidence shows that management has materially embellished Heska’s market share, business model, and product development capabilities while failing to disclose increasing risks to its challenged competitive positioning. We are troubled that management continually characterizes revenue gained through acquisitions as organic growth. By analyzing revenue growth rates relative to key competitors, we find that Heska’s claims of massive market share gain since 2013 are overstated and that the Company has actually lost ground in recent periods. Moreover, we find evidence that shows management’s efforts to re-position the Company as an innovator is wildly inconsistent with modest incremental R&D spend and declining capital expenditures (to well below $1 million in 2020). Despite eliminating disclosures related to third-party suppliers and taking credit for supplier product development activities, we believe the Heska of today is no less dependent on other original equipment manufacturers for its revenue, which we believe exposes the Company to numerous undisclosed threats, including the risk of suppliers bypassing Heska distribution to sell directly to customers.
Our in-depth analysis of Heska’s recent acquisitions reveals a pattern of acquiring low-quality assets to create the perception of an expanded product offering on par with the sector’s leaders. Heska acquired scil animal care company ("scil"), a European distributor, in early 2020 for $110 million in the largest deal in Company history. We find that scil has a poor track record of growth (-1% CAGR from 2014 to 2019) and profitability (gross margins more than 13 percentage points lower than Heska’s 2019 levels), had lost a major customer prior to the transaction, and, despite Heska’s claims, added no R&D capability. We also question Heska’s claims that it will be able to transition scil customers to Heska subscriptions. In Heska’s other transactions, we find an assortment of low-quality targets with a range of undisclosed issues, including negative revenue growth (CVM), widespread employee departures and questionable competitive positioning (Lacuna Diagnostics), the acquisition of a Heska distributor (Optomed), potential mischaracterization of profitability (BiEssiA), and signs of material embellishment of capabilities and market position (Biotech Labs).
Market due diligence and management commentary suggest Heska’s highly anticipated product, the Element AIM, will disappoint. Heska has promoted its development and manufacture of a new point of care urine/fecal analyzer as a major accomplishment that will contribute over 10% of 2022 revenue. However, based on our discussions with several dozen veterinarians, we find minimal interest in migrating away from current centralized reference lab testing for such samples. Furthermore, after more than a year from its original timing, Heska’s product is already late to market given Zoetis’ launch of its VETSCAN IMAGYST product in September 2020. Most importantly, we are troubled by management’s inconsistent or inadequate disclosure regarding the Element AIM, including the failure to explain its architecture or differentiating characteristics, the lack of published research on the machine’s testing performance, and nonsensical commentary on commercial launch timing, supply chain issues, alternative fecal testing solutions, and veterinarian buying behavior.
We have identified numerous examples of incorrect, inconsistent, or inadequate financial disclosures, including a large disposal of the hazardous chemical mercury. Arguably the most valuable part of Heska’s business are the subscription revenues it earns on the sale of consumables. However, we find evidence that these subscriptions comprise only a small portion of revenue and are not differentiated in the market, except perhaps on the basis of price. More importantly, we identified reporting issues with Heska’s subscription disclosures, including evidence of miscalculations and reduced disclosures following negative trends, including a precipitous decline in contract value per subscriber per month in 2020 with further declines expected in 2021. We also identify financial disclosure issues related to the scil transaction. More broadly, we show that Heska’s financial transparency is markedly worse than that of industry leader IDEXX Laboratories. In particular, we are highly troubled by a lack of disclosure around a large pharmaceutical product return by a customer in 2019. The product return is inconsistent with the Company’s stated return policies, a deviation from which should have necessitated additional disclosure, and at the very least might have been accompanied by a material asset write-down. Most shocking, we show that the product return required Heska to make a historically large disposal of mercury, a dangerous chemical which has not been disclosed to investors.
We find numerous governance failures at Heska – including that its underwriter and bullish equity promoter Piper Sandler employs the children of Heska Chief Executive Officer Kevin Wilson – that should make the shares un-investable for funds that place even the slightest weight on ESG considerations. While some might consider Heska’s rich history of related party transactions with entities owned by Mr. Wilson (that explicitly violated the Company’s Code of Ethics) to be "old news," we show that Heska continues to suffer from a range of conflicts of interest and governance failures. Despite questionable financial performance and Mr. Wilson continuing to allocate time to his other business, Cuattro, Heska’s Board of Directors recently rewarded him with an egregious compensation package that includes cash compensation well above industry peers and a $43 million stock grant that is 1.5x higher than Heska's total net income generated since Mr. Wilson joined the Company in 2013. We are also highly troubled by the lack of disclosure surrounding the employment of Mr. Wilson’s two sons in investment banking at Heska’s lead underwriter and unabashed research cheerleader, Piper Sandler. Additionally, we find that Heska Board Chairman Scott Humphrey has several undisclosed business roles despite claiming to be retired, and that director David Sveen has engaged in suspicious financial transactions between his consulting firm and family nonprofit organization. Finally, we are troubled by evidence that Chief Financial Officer Catherine Grassman has been disciplined by the Colorado State Board of Accountancy and by the promotion of two lawyers with a distinct lack of prior industry operating experience to key operational roles at the Company.
Heska’s current premium valuation is nonsensical, which is why Spruce Point estimates up to 60% downside in the Company’s shares. Heska is currently trading at 9x and 77x 2022E consensus revenue and EBITDA, respectively, premium levels most commonly associated with high growth technology leaders as opposed to low margin distributors like Heska. We find Heska’s valuation particularly irrational given (1) the Company acquired approximately 40% of its revenue through acquisitions over the past year-and-a-half for an aggregate valuation of only 1.4x revenue, and (2) Heska’s troubled PVD and OVP segments, which represent approximately 20% of revenue, clearly deserve a discounted multiple given their modest growth prospects, low margins, and non-strategic nature. When we assign the deal values to the acquired businesses, we find that the market is valuing Heska’s North American business at 17.5x revenue, on par with vastly superior market leader IDEXX Laboratories. We even find that Heska is trading in-line with or at a slight discount to two highly differentiated, massive-growth diagnostic equipment companies that recently came public via SPAC transactions. Based on our sum-of-the-parts analysis, we see 50% - 60% downside risk in Heska shares to $90-$115 per share.
Please note that the items summarized in this press release are expanded upon and supported with data, public filings and records, and images in Spruce Point’s full report. As a reminder, our full report, along with its investment disclaimers, can be downloaded and viewed at www.SprucePointCap.com.
As disclosed, Spruce Point has a short position in Heska and owns derivative securities that stand to net benefit if its share price falls.
About Spruce Point
Spruce Point Capital Management, LLC is a forensic fundamentally-oriented investment manager that focuses on short-selling, value and special situation investment opportunities. Spruce Point Capital Management, LLC is a member of the Financial Industry Regulatory Authority, CRD number 288248.
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